Performance Measure Properties and the Effect of Incentive Contracts

Abstract

Using data from a third-party survey on compensation practices at 151 Dutch firms, we show that less noisy or distorted performance measures and higher cash bonuses are associated with improved employee selection and better-directed effort. Specifically, (1) an increase in the cash bonus increases the perceived selection effects of incentive contracts, but does not independently affect the perceived amount and direction of effort that employees deliver, and (2) performance measure properties directly impact both effort and the selection functioning of incentive contracts. These results hold after controlling for an array of incentive contract design characteristics and for differences in organizational context. Our estimation procedures address several known problems with using secondary datasets.

More from these Authors

In this study we describe target setting and target achievements for a car dealership. Car dealers are eligible for a discount on the purchase price conditional on their achieving the sales targets set by the franchisor. We show that car dealers (franchisees) who exclusively deal in cars of the brand offered by the franchisor receive easier targets and are more likely to exert effort in achieving their targets compared to dealers who also acquire brands outside of the franchise network. As a consequence the exclusive dealers receive a relatively bigger cut of the total amount of discounts that dealers are offered conditional on their achieving sales targets set by the franchisor. We explain these results in terms of how much franchisors and franchisees believe that their relations will last or will be intensified in the future. We leverage on relational-contracts theory to develop our predictions and interpret our findings.

This study examines how control elements of a firm affect coordination among profit centers. The firm operates a network of 59 profit centers. It uses a transfer-pricing system designed to account for interdependencies between profit centers and to induce coordination. Further, profit center managers are incentivized with own-level residual income measures. The use of the latter measure would lead managers to make decisions benefiting their performance irrespective of whether these decisions negatively affect other profit centers. However, the firm implemented a third system that would potentially lead managers to benefit other profit centers. The firm established regional clusters of profit centers that meet at least once every quarter. The creation of these clusters creates proximity as profit centers perform complementary activities, making it more beneficial for them to coordinate. Our findings suggest that self-centered choices by profit centers are mitigated as proximity within a cluster increases. Additionally, we find evidence that proximity is positively associated with coordination and overall performance.

This paper examines the relation between managerial ownership and bank risk exposure for a large sample of international financial institutions. We seek empirical evidence suggested by theories concerning conflicts between managers and owners over risk-taking. We argue that managers holding equity of their bank take less risk because they have fewer opportunities to diversify risk compared with outside shareholders. Our findings are consistent with this idea. We document lower risk levels for banks that employ bank managers with higher equity stakes. Our evidence also suggests that external shareholders affect risk taking via directors representing their interests. We also demonstrate that regulation hardly affects the risk-taking of bank managers holding on their bank's shares. This contrasts with outside shareholders who are more likely to expose their bank to higher risk levels when regulation protects the bank against default. Managerial equity incentives may, therefore, serve as a risk reduction instrument.